The risk of low inflation becoming embedded in New Zealand seems to rise substantially when two-year-ahead expectations are analysed, HSBC chief economist Paul Bloxham says.
The Reserve Bank's key measure of two-year inflation expectations lifted slightly to 1.64% in the second quarter of the year, still near a record low and well below the central bank's inflation target of 2%.
"We see this measure as low enough to still worry the Reserve Bank [that] inflation expectations are becoming embedded at a below-target rate.''
New Zealand had experienced low inflation for several years and that had become increasingly embedded in inflation expectations, he said.
The Reserve Bank had sought to downplay the extent of the weakness in headline inflation, pointing to temporary effects such as oil prices and the exchange rate, as well as focusing on its own estimate of underlying inflation.
All those factors, along with robust economic growth, supported the theory inflation would eventually return to target.
However, the risk of low inflation becoming embedded seemed to rise substantially when the two-year-ahead inflation expectations dropped markedly in the first quarter from 1.83% to 1.63%, Mr Bloxham said.
"We believe the decline was the key motivation for the Reserve Bank's March cash rate cut, with the central bank increasing its references to needing to make sure inflation expectations remained well anchored near the 2% medium-term target.''
Figures released this week suggested the March cut, although earlier than most were expecting, had yet to convince survey respondents the Reserve Bank would be able to lift inflation to 2% within two years, he said.
The lift in the one-year measure from 1.09% to 1.22% was also modest, considering the strong rally in oil prices over the last two months.
The Reserve Bank continued to face a challenge getting inflation back to its target and make sure inflation expectations were well anchored at the near 2% target.
Concerns about inflation expectations still being too low would mean the Reserve Bank cuttings its cash rate further in June, despite concerns over the strength of the Auckland housing market, Mr Bloxham said.
